Question

42. A company has a proposed 2-year project with the cash flows shown below and would like to calculate the NPV of this project so that they can decide whether to pursue the project or not. The company has a target capital structure of 60% equity and 40% debt. The beta for this firms stock is 1.4, the risk-free rate is 4.5, and the expected market risk premium is 6.4%. The bonds for this company pay interest semiannually and have a coupon interest rate of 6%, 16 years to maturity, a face value of $1,000, and a current price of 1,108.64. If the corporate tax rate is 32%, what is the NPV of the proposed project for this firm? (Answer to the nearest dollar, but do not use a dollar sign).

  

Years	Cash Flows
0	-3,000
1	1,000
2	3,000

Answer 1

		5%						6%
Year	Cash Flow	PV fatctor = 1/ (1+r)^t	PV			Year	Cash Flow	PV fatctor = 1/ (1+r)^t	PV
0	(1,108.64)	1.000	(1,108.64)			0	(1,108.64)	1.000	(1,108.64)
0.5	30	0.976	29.28			0.5	30	0.971	29.14
1	30	0.952	28.57			1	30	0.943	28.30
1.5	30	0.929	27.88			1.5	30	0.916	27.49
2	30	0.907	27.21			2	30	0.890	26.70
2.5	30	0.885	26.56			2.5	30	0.864	25.93
3	30	0.864	25.92			3	30	0.840	25.19
3.5	30	0.843	25.29			3.5	30	0.816	24.47
4	30	0.823	24.68			4	30	0.792	23.76
4.5	30	0.803	24.09			4.5	30	0.769	23.08
5	30	0.784	23.51			5	30	0.747	22.42
5.5	30	0.765	22.94			5.5	30	0.726	21.77
6	30	0.746	22.39			6	30	0.705	21.15
6.5	30	0.728	21.85			6.5	30	0.685	20.54
7	30	0.711	21.32			7	30	0.665	19.95
7.5	30	0.694	20.81			7.5	30	0.646	19.38
8	30	0.677	20.31			8	30	0.627	18.82
8.5	30	0.661	19.82			8.5	30	0.609	18.28
9	30	0.645	19.34			9	30	0.592	17.76
9.5	30	0.629	18.87			9.5	30	0.575	17.25
10	30	0.614	18.42			10	30	0.558	16.75
10.5	30	0.599	17.97			10.5	30	0.542	16.27
11	30	0.585	17.54			11	30	0.527	15.80
11.5	30	0.571	17.12			11.5	30	0.512	15.35
12	30	0.557	16.71			12	30	0.497	14.91
12.5	30	0.543	16.30			12.5	30	0.483	14.48
13	30	0.530	15.91			13	30	0.469	14.07
13.5	30	0.518	15.53			13.5	30	0.455	13.66
14	30	0.505	15.15			14	30	0.442	13.27
14.5	30	0.493	14.79			14.5	30	0.430	12.89
15	30	0.481	14.43			15	30	0.417	12.52
15.5	30	0.469	14.08			15.5	30	0.405	12.16
16	30	0.458	13.74			16	30	0.394	11.81
16	1,000	0.458	458.11			16	1,000	0.394	393.65
		Total	7.77					Total	(99.68)
NPV @ 5%	7.77
NPV @ 8%	(99.68)
Difference in both	107.44
YTM	=Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV)
	=5%+1% *(7.77/107.44)
YTM	5.07%
Tax rate	32.00%
After tax cost	5.07% * (1-32%)
After tax cost	3.45%
Cost of equity=	Risk free rate + Beta * Market risk premium
Cost of equity=	4.5%+1.4*6.4%
Cost of equity=	13.46%
Component	Cost		Weight	Cost * Weight
Debt	3.45%		40.00%	1.379%
Equity	13.46%		60.00%	8.076%
			WACC	9.455%

Project A		9.455%
		NPV@ 0.09455
Year	Cash flow	PV factor	PV-Cash flow
0	(3,000.00)	1.000	(3,000.00)
1	1,000.00	0.914	913.62
2	3,000.00	0.835	2,504.09
		NPV	417.71